Bond rally may extend if RBI tempers hawkish tone

Indian bonds are likely to extend their rally in the coming weeks as the central bank is seen tempering its hawkish tone at the monetary policy review next Wednesday, comforted by lower consumer price inflation in April.

Published: June 1, 2017 5:46 AM

The yield on short-term papers is likely to see a smaller movement of about 10 basis points. (Image: Reuters)

Shamik Paul

Indian bonds are likely to extend their rally in the coming weeks as the central bank is seen tempering its hawkish tone at the monetary policy review next Wednesday, comforted by lower consumer price inflation in April. However, traders feels it is too early for the Reserve Bank of India to change its monetary policy stance based on one inflation print and they will be closely following the RBI’s tone at the policy review for more clarity on further rate actions. They expect the RBI to wait for at least 3-4 inflation data before changing its stance.

The yield on the old benchmark 6.97% 2026 bond, which has fallen about 20 basis points from a nearly 9-month high of 6.99% on May 2, could decline by another 15-20 basis points if the RBI maintains a neutral tone, traders said.
The benchmark yield had risen sharply on April 21, a day after the RBI released the minutes of the monetary policy committee meeting where RBI executive director Michael Patra was of the view that a pre-emptive 25-basis-point hike in the policy rate was required to prevent the need for ‘back-loaded’ policy action once inflation was already too high.

Traders expect the new benchmark 10-year 6.79% 2027 bond to trade around 6.45%-6.50% levels. The paper, which started trading from May 15, has rallied 13 basis points since then. It touched 6.65% earlier this week, its highest level since April 5. The yield on the short-term papers are likely to see a smaller movement of about 10 basis points, traders said. The 3-month T-bills yield has risen 8 basis points since the beginning of the month to 6.27%, while the yield on the 1-month T-bills has gained 6 basis points to 6.17%.

“The RBI will be cautious, but not hawkish. They will acknowledge that inflation has fallen. Also, they cannot ignore that the government has come out with a better-then-expected GST formula,” said Naveen Singh, senior vice president at ICICI Securities Primary Dealership.

India’s retail price inflation dropped to a record low at 2.99% in April from a nearly five-month high of 3.89% in March on a lower base effect and lower food prices. However, despite the lower inflation print, the GST and favourable monsoons forecast, it might be difficult for the RBI to be dovish because of the excess liquidity in
the banking system, Singh said, adding that such a situation could stoke inflationary expectations.

The surplus liquidity in the banking system, which swelled following the government’s move to ban high-denomination currency notes in November last year, is around Rs 3.3 lakh crore. “With average inflation in the first half of FY18 likely to be around 130 bps lower than RBI’s estimates, the policy stance should soften as early as in the June meeting. A lower-than-expected trajectory for the RBI should prompt it to take a re-look into its current views,” Kotak Economic Research wrote in a recent note.

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Kotak said the GST rates will likely lead to about 20 bps fall in CPI inflation, assuming smooth implementation and efficient input tax mechanism, with most goods’ rates broadly unchanged and in some cases lower and only a few services seeing some uptick.

However, the benchmark bond yields could go up by 15 to 20 basis points if the RBI continues to be hawkish, traders said. In a recent note, Nomura said although GST will be dis-inflationary in the longer term, it is unlikely to transpire immediately. “Given much of the ongoing drop in inflation is due to transitory factors, and considering other factors in the pipeline (narrowing output gap, remonetisation, house rent allowance increase), we continue to see the RBI’s next move as a hike rather than a cut,” Nomura wrote.